At Tuesday’s debate, McCain introduced a new program to help people out with their mortgages. The details are still emerging, but the gist seems to be that the government would buy underwater mortgages outright from banks, thereby preserving their equity. They would then revalue the mortgage at 100% of the current market value of the property and set up a new loan to the homeowner to finance that new value.

I think an example is in order. Let’s say you bought a $200k home which is currently only worth $150k, even though you still owe $190k on the property. The bank now has a problem, at least on paper. The problem is that its butt is exposed because the collateral no longer covers the loan value. Arguably, as long as you continue to make your payments, the bank isn’t actually out any money, but due to the way the books are kept, they have a liability exposure. Now if you default on the loan, then they have a real problem. It’s reasonable to assume that the banks are only interested in unloading the bad credit risks. The people they think are likely to default. So let’s assume you are one of them.

The government comes in and pays the bank $190k for your mortgage. The bank goes away happy. The government then says that it will restructure your loan at $150k. Presumably you can make those payments. What about the $40k? That money is absorbed by the taxpayers. Or let’s look at this slightly differently. The government gives you $40k to apply toward the principle on your mortgage, and then renegotiates your loan terms.

It’s hard to know where to begin. Let’s start with fairness. This plan is not. Minimally, it rewards people who took on debt they couldn’t handle. Those who already have homes without mortgages exceeding the value, and those who took to purchasing homes at rates and prices they could afford, get nothing. We would be rewarding the wrong behavior here. Further, when and if home values rise again, the taxpayer gets none of the upside of this deal. If two years from now, the example house is again worth $200k, it may be sold for that, and the homeowner walks away with the $40k in their pocket. Again, not fair. Keep in mind that this proposal is from the party that opposes socialism or any form of government handouts.

But the really brain dead part of this would seem to be that it can’t be reasonably implemented. The only people who qualify are people who have decent credit, a means of making payments, and impending delinquency. In other words, people who took out cheap adjustable rate mortgages and could make the payments at the lower rates, but cannot make the payments now that the actual terms of the loan have kicked in. But by definition, these people aren’t suffering from market devaluation of their homes. They’re suffering from predatory lending practices (and maybe some naivete). They do need a renegotiated loan, but the loan amount is what it is and should remain that. If the banks require additional collateral or insurance to make the loans solvent on their books, then this would be a good use of the $700b rescue money. But it’s not clear why anyone has to eat the market devaluation.

By McCain’s own proposal, people who are forced to bail on an underwater loan because of unemployment, the need to move/sell a home, or whatever, would not be helped by this plan. Somebody’s still going to eat that loss. This plan only helps the marginal cases. And its primary help is in providing the loan renegotiation. Why he’s throwing in the bonus principle payment seems a mystery. It’s a nice gift if you’re on the receiving end,but devaluation is only an issue if you’re trying to sell or otherwise liquidate the property—not if you’re trying to live there.

But again, maybe I’m missing something. Feel free to set me straight.